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Stock Spotlight: Video Games Stocks

by: Michael R. Abramowitz

Video games are big business and very popular on college campuses nationwide. You might be one of those spending an arm, leg and very sore wrist on the latest, greatest incarnation of Madden NFL 06 or Grand Theft Auto. But perhaps the video game industry can put some meal money back in your pocket by investing in the stocks of game makers. It’s a big business, but are the best days for investors of video game makers behind them? Let’s take a look…

Electronic Arts (ERTS)

Snapshot:If it’s in the game, it’s in the game. Electronic Arts is home to the mega popular Madden NFL line of videogames and other highly popular titles such as NCAA Football 06.

Recent Price: $59.56

Pros:

The company’s EA Sports division sells hit after hit after hit, featured by a record 1.7 million copies of Madden NFL06 sold during the first week it was on the shelves in August.

EA’s NCAA Football 2006was the number one selling title during July for PlayStation video games and number two for Xbox.

With revenues of more than $3 billion, Electronic Arts is a work of art on the balance sheet. The company has zero debt and more than $2.45 billion in cash on-hand.

Cons:

A bitter pricing battle with rival Take-Two Interactive forced Electronic Arts to sign highly expensive exclusivity contracts with the NFL and ESPN. The good: These deals prevented Take-Two from issuing a competing NFL game. The bad: The multimillion dollar price tag will take a significant chunk out of Electronic Arts’ bottom line.

Earnings per share are expected to decline by -8% for the current 2006 fiscal year because of higher costs to develop new games.

The stock price is at the mercy of the fickle teen and college crowd, which may bore of playing video games after they establish themselves in the “real world.”

Take-Two Interactive Software, Inc. (TTWO)

Snapshot:Follow that car! Take-Two’s Rockstar Games division is the maker of the ever-popular Grand Theft Auto. Meanwhile, 2K Games is the company’s other main game maker, but the loss of its exclusivity contract with ESPN is quite a fumble.

Recent Price:$24.72

Pros:

While the rest of the industry is expected to decline by an estimated 1.2%, according to analysts, Take-Two is expected to see a sweet 20% earnings jump.

Trading at 16 times forward earnings, Take-Two is selling for a fairly good premium, if you can believe analyst’s expectations for growth.

With $210 million in cash on-hand and no debt, the company’s balance sheet is in decent shape.

Cons:

The loss of the ESPN product line to rival EA may affect on earnings at some point.

While the company is debt-free, it has negative free cash flow, which likely means that they are spending money as soon as it comes in the door. However, a good assumption is that cash is chiefly going towards research and development of new games.

While Take-Two’s stock is trading at levels that are five-fold higher than it was five years ago, the shares have the volatility of an audience rating for Grand Theft Auto, so it’s not an investment for the weak of heart.

Activision (ATVI)

Snapshot:An up and coming player in the video game market, Activision is the producer of such hits as Doom and the Tony Hawk line of video games.

Recent Price:$19.99

Pros:

Expect surprises to the upside with Activision, as the last four quarters, the company has beat earnings per share estimates by 57% on average.

Shares of Activision have ridden higher than Tony Hawk performing a death-defying back flip on his skate board ramp – up 33% since splitting 4 for 3 earlier this year.

Activision earns the bulk of its 71 cents a share in earnings in the fourth quarter typically, so the time to buy might be on any dips in share price before the holidays start.

Cons:

Activision earnings, while growing, are only expected to jump a measly 4.4% this year.

With earnings patterns very similar to a big box retailer, investors have to wade through three quarters of negative earnings before getting to Activision’s profit nirvana – the holiday shopping season.

Trading at 33 times earnings, investors might want to wait for a break in the stock market and in Activision’s share price before jumping in with both feet.

The video game industry’s shares can be a wild ride, and companies can make it or break it depending on the release of the latest, greatest title. In many ways, it is similar to the movie industry, and the price tags for creating video games are starting to get in the stratosphere. Investors should be willing to ride out inevitable hiccups in video game stocks before spending any money in this sector.

Price quotes are from September 14, 2005.

Michael Abramowitz is a freelance writer based in Florida. To avoid a conflict of interest, he does not currently own any of the stocks mentioned above.